nep-cba New Economics Papers
on Central Banking
Issue of 2023‒02‒13
27 papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Why Follow the Fed? Monetary Policy in Times of US Tightening By Gonzalo Huertas
  2. The Global Transmission of U.S. Monetary Policy By Riccardo Degasperi; Seokki Simon Hong; Giovanni Ricco
  3. Macro-Financial Stability in the COVID-19 Crisis: Some Reflections By Mahvash S Qureshi; Mr. Tobias Adrian; Mr. Fabio M Natalucci
  4. Uzbekistan's Transition to Inflation Targeting By Ezequiel Cabezon; Moayad Al Rasasi
  5. Do the projected fiscal deficits play a role in ECB monetary policymaking? By Linas Jurkšas; Francisco Gomes Pereira
  6. Systemwide Liquidity Stress Testing Tool By Ms. Hiroko Oura
  7. On Speculative Frenzies and Stabilization Policy By Gadi Barlevy
  8. What are Central Bank Digital Currencies (CBDC)? An introduction to their main features, opportunities and potential risks By Sebastián Katz
  9. Inflation Surprises in a New Keynesian Economy with a True Consumption Function By Roberto Tamborini
  10. Bottleneck effects of monetary policy By Emilia Garcia-Appendini; Frédéric Boissay; Steven Ongena
  11. House Price Expectations, Household Indebtedness and Macroprudential Policy in Slovakia By Indrani Manna; Martin Suster; Biswajit Banerjee
  12. Four mistakes in the use of measures of expected inflation By Ricardo Reis
  13. The European monetary policy responses during the pandemic crisis By Benigno Pierpaolo; Canofari Paolo; Di Bartolomeo Giovanni; Messori Marcello
  14. Balance Sheet Expansionary Policies in the Euro Area: Macroeconomic Impacts and a Vulnerable versus Non-Vulnerable Comparison - A Bayesian Structural VAR Approach By Francisco Gomes Pereira
  15. Fiscal Progressivity and the Time Consistency of Monetary Policy By Antoine Camous
  16. The 2021–22 Surge in Inflation By Oleksiy Kryvtsov; James (Jim) C. MacGee; Luis Uzeda
  17. Does BRRD mitigate the bank-to-sovereign risk channel? By Martien Lamers; Thomas Present; Nicolas Soenen; Rudi Vander Vennet
  18. The labor share and the monetary transmission By Bernardino Adão; André Silva; João Gama
  19. The Pricing-Out Phenomenon in the U.S. Housing Market By Mr. Yunhui Zhao; Francesco Beraldi
  20. Sovereign debt crisis, fiscal consolidation, and active central bankers in a monetary union By Canofari Paolo; Di Bartolomeo Giovanni; Messori Marcello
  21. A single monetary policy for heterogeneous labour markets: the case of the euro area By Sandra Gomes; Pascal Jacquinot; Matija Lozej
  22. Liquidity Regulation and Bank Risk Taking on the Horizon By Joshua Bosshardt; Ali Kakhbod; Farzad Saidi
  23. Stock Market Liquidity, Monetary Policy and the Business Cycle By Markus Leippold; Vincent Wolff
  24. Energy Prices and Household Heterogeneity: Monetary Policy in a Gas-TANK By Chan, Jenny; Diz, Sebastian; Kanngiesser, Derrick
  25. Central Bank Balance Sheet Expansion in a Dollarized Economy: The Case of Ecuador By Julien Reynaud; Juan-Pablo Erraez
  26. Risk Amplification Macro Model (RAMM) By Kerem Tuzcuoglu
  27. Stagflation and fragmentation: The euro area at the crossroad By Benigno Pierpaolo; Canofari Paolo; Di Bartolomeo Giovanni; Messori Marcello

  1. By: Gonzalo Huertas
    Abstract: I conduct interviews with 32 Central Bankers from Emerging Markets and present five unifying themes that explain their behavior when reacting to a U.S. monetary tightening. I then estimate the impulse response functions of their two main monetary tools, the policy rate and foreign exchange interventions, to an increase in the U.S. rate, using the answers from the interviews as a guide for the best econometric specification. I find that most Central Banks react to a U.S. tightening by raising domestic rates, regardless of the exchange rate regime, but their reasons for doing so vary – from controlling inflation to preventing capital outflows.
    Keywords: Monetary policy; emerging markets. international spillovers; global interest rates; trilemma.
    Date: 2022–12–09
  2. By: Riccardo Degasperi (DG Economics, Statistics and Research, Rome, Italy); Seokki Simon Hong (Paris School of Economics, Paris, France); Giovanni Ricco (CREST – Ecole Polytechnique, Palaiseau, France)
    Abstract: US monetary policy shapes economic conditions globally due to the dominant role of the dollar in the world economy. We study the propagation of US monetary policy shocks abroad using a state-of-the-art high-frequency identification and a harmonised dataset covering 30 economies and over 150, 000 datapoints. A policy tightening has large contractionary effects on both advanced and emerging economies. The propagation via financial variables limits foreign central banks’ control over domestic economic conditions by increasing risk premia and by destabilising the medium-long segment of the yield curve. The responses of headline prices abroad are instead shaped by spillovers via commodity markets.
    Keywords: Monetary policy, Trilemma, Exchange Rates, Monetary Policy Spillovers.
    JEL: E5 F3 F4 C3
    Date: 2022–01–13
  3. By: Mahvash S Qureshi; Mr. Tobias Adrian; Mr. Fabio M Natalucci
    Abstract: The global financial system has shown remarkable resilience during the COVID-19 pandemic, despite a sharp decline in economic activity and the initial financial market upheaval in March 2020. This paper takes stock of the factors that contributed to this resilience, focusing on the role of monetary and financial policies. In response to the pandemic-induced crisis, major central banks acted swiftly and decisively, cutting policy rates, introducing new asset purchase programs, providing liquidity support for the banking system, and creating several emergency facilities to sustain the flow of credit to the real economy. Several emerging market central banks also deployed asset purchase programs for the first time. While the pandemic crisis has underscored the importance of policies in preventing calamitous financial outcomes, it has also brought to the fore some unintended consequences of policy actions—in particular, of providing prolonged monetary policy support and applying regulation to specific segments of the financial system rather than taking a broader approach—that could undermine financial stability in the future.
    Keywords: COVID-19 pandemic crisis; monetary policy; financial stability; emerging markets; central bank asset; purchase program; monetary policy support; market liquidity; asset purchase; COVID-19; Inflation; Global financial crisis of 2008-2009; Capital flows; Financial sector stability; Global
    Date: 2022–12–16
  4. By: Ezequiel Cabezon; Moayad Al Rasasi
    Abstract: Uzbekistan has significantly improved its monetary policy framework during 2017-21. Nevertheless, the transition to inflation targeting is challenging as the country is going through a period of deep structural reforms. Therefore, the Central Bank of Uzbekistan (CBU) will have to monitor structural reforms and calibrate monetary policy accordingly. This paper identifies institutional and structural gaps, and assesses the effectiveness of monetary policy transmission. Institutional gaps are assessed using institutional indexes while transmission is assessed using VARs. It concludes that in the coming years, reforms will need to continue, to further improve the CBU’s governance and independence, develop financial markets, but most of all to reduce the still large footprint of the state in the financial sector as well as in the overall economy.
    Keywords: Uzbekistan; Inflation targeting; Monetary policy; post inflation targeting implementation; monetary policy outcome; monetary policy transmission; inflation targeting condition; transition to inflation targeting; transmission mechanism; Central bank policy rate; Inflation; Dollarization; Currency markets; Global; Central Asia and the Caucasus
    Date: 2022–11–18
  5. By: Linas Jurkšas; Francisco Gomes Pereira
    Abstract: We estimate a large number of alternative monetary policy reaction functions for the ECB in order to robustly find if fiscal stance matters for the monetary policy conduct. We use GMM and SVAR methods to estimate inflation-output reaction functions with and without a fiscal deficit indicator from 2001 until 2022 with the thick-modelling approach. The results revealed that ECB actions have exhibited desirable stabilising monetary policy properties and have generally been found to be consistent with the Taylor principle. Most importantly, the projected euro area fiscal deficit usually is not statistically significant in explaining ECB monetary policy stance. Nevertheless, when the fiscal deficit indicator is statistically significant, the sign of its coefficient is always positive, implying that increasing deficits lead to a more restrictive monetary policy stance. These findings speak against the “fiscal dominance” regime in the euro area where monetary policy is single and fiscal policies are decentralised. The results remain qualitatively similar independent of the precise specification of the GMM and SVAR models and if the sample period is shortened from 2012.
    Keywords: ECB; monetary policy; reaction function; Taylor rule; fiscal deficits; fiscal stance
    JEL: E43 E52 E58 E61 E62 H62
    Date: 2023–01
  6. By: Ms. Hiroko Oura
    Abstract: Developing a systemic liquidity stress testing tool is challenging due to data constraints and hard-to-model behavioral factors. There has yet to be a uniformly accepted model partly because the nature of systemic liquidity risks differs significantly across countries. This paper offers a simple Excel-based tool to assess the high-level impact of aggregate liquidity stress on the whole economy and gauge its spillover across banks, non-bank financial institutions (NBFIs), and non-financial economic sectors. It primarily uses the balance sheet approach (BSA) data—a sector-aggregate matrix of financial exposure by counterpart—that have become increasingly available for various economies with all income levels. The results can identify systemically important financial linkages to be analyzed further and help calibrate macroprudential measures and a liquidity support framework. When liquidity stress stems from capital outflows, the tool can enrich policy discussion based on integrated policy framework (IPF) and international reserve adequacy perspectives.
    Keywords: Systemic liquidity; NBFIs; stress test; integrated policy framework; capital flow; international reserve adequacy; interconnectedness; balance sheet approach; macroprudential policy; financial stability; central bank FX liquidity buffer; cashflow liquidity stress test; liquidity support framework; systemwide liquidity risk; central bank liquidity provision; Liquidity; Liquidity stress testing; International reserves; Stress testing; Global
    Date: 2022–12–16
  7. By: Gadi Barlevy
    Abstract: This paper examines whether tasking central banks with leaning against asset booms can conflict with their existing mandates to stabilize goods prices and output. The paper embeds the Harrison and Kreps (1978) model of speculative booms in a monetary model based on Rocheteau, Weill, and Wong (2018). In the model, a speculation shock that generates an asset boom is associated with higher output but a lower price level, unlike aggregate demand shocks that raise both output and prices. This creates a trilemma for central banks in that contemporaneous monetary policy cannot simultaneously stabilize output, the price level, and real asset prices. Stabilizing all three requires alternative policies.
    Date: 2022–08–03
  8. By: Sebastián Katz (Central Bank of Argentina)
    Abstract: Digital transformation is provoking a real revolution in the payment´s landscape of many economies in the last few years. New technologies and the change in public´s habits are transforming not only the way payments are processed but the very modes of registering, storing and transferring value among economic agents. In that sense, a potential change in the forms of money as social convention or institution is also taking place. Many of these trends were accelerated by the pandemic. As a consequence of these developments, Central Banks started to actively explore the possibility of issuing their own digital monetary liabilities directed towards the general public, or retail CBDC (Central Bank Digital Currency). Many of them have progressed from conceptual research towards practical experimentation and a few jurisdictions have decided to implement it in the last period. This working paper presents a general overview of these efforts, the potential benefits that could derive from this initiative and the alternative designs and architectures under study oriented to minimize some of its risks.
    Keywords: Central Bank digital currencies, crytoassets, money, payment systems, stablecoins
    JEL: E42 E58 F42 G21
    Date: 2022–04
  9. By: Roberto Tamborini
    Abstract: The resurgence of inflation since the late 2021 is now accompanied by a reversal of prospects of growth, reviving fears of stagflation across the world (IMF 2022, World Bank 2022). In almost all accounts of the mounting stagflation threats a prominent role is played by the fall of households' purchasing power, and hence consumption, owing to the inflation shock visà-vis nominal wages lagging behind. The theoretical issue that motivates this paper is that this endogenous real income effect of inflation surprises, independent of restrictive monetary policy, is not present in the standard New Keynesian models for monetary policy. The paper shows how this channel can be introduced reformulating the consumption function, with the consequence that it exerts a stabilisation effect on inflation endogenously. By means of simulations the paper discusses the main monetary policy implication: what is the role left to monetary policy which purports to curb inflation in the same way?
    Keywords: cost-push inflation, real income effect, stagflation, New Keynesian models for monetary policy
    JEL: E17 E30 E50
    Date: 2022
  10. By: Emilia Garcia-Appendini (University of Zurich - Department of Banking and Finance); Frédéric Boissay (Bank for International Settlements (BIS)); Steven Ongena (University of Zurich - Department of Banking and Finance; Swiss Finance Institute; KU Leuven; NTNU Business School; Centre for Economic Policy Research (CEPR))
    Abstract: Is monetary policy transmitted through markets for intermediate goods? Analyzing US data on corporate linkages, we document that the financial health of downstream and upstream firms plays a key role in monetary policy transmission. Our estimates suggest that contractionary changes in monetary conditions lead to reductions in demand and supply of financially constrained firms downstream and upstream. These reductions create bottlenecks inducing the "middle" linked firms to curtail their own activities. Overall these "bottleneck effects" coming from changes in demand and supply by constrained partners have a larger impact on a firm's operations than the firm's own financial conditions.
    Keywords: Monetary policy transmission, supply chain, aggregate demand, cost channel.
    JEL: E52 G32
    Date: 2022–12
  11. By: Indrani Manna; Martin Suster; Biswajit Banerjee (National Bank of Slovakia)
    Abstract: By incorporating a data generating process for house price expectations in a standard new-Keynesian DSGE model calibrated to Slovakia, this paper differentiates between the macroeconomic impact of endogenous and exogenous sources of expectation shocks and the role of fiscal and macroprudential policy (in the absence of monetary policy) in managing these shocks in the housing market. The paper concludes that endogenous shocks pre-dominate exogenous shocks to expectations in home prices in accelerating credit growth and household indebtedness. But endogenous shocks can still be accredited with ’good housing booms’ tag as they raise the ability to pay-off rising debt significantly. In terms of policy, the paper finds that loan-to-value ratios score over payment to income ratios as a potent macroprudential instrument to manage housing market dynamics as constraint switching is limited in case of LTV because of an expectation sensitive factor market. Macroprudential instruments set as a function of household debt to GDP ratio reinforces the transmission channels and turn out to be counterproductive in case of endogenous shocks but effective in managing exogenous shocks. The paper also finds that property tax can be potential instrument to arrest rising house prices, but it works effectively in coordination with other policies. We also show that endogenous refinancing decisions of households can be effectively used as a channel for transmission of monetary and macroprudential policy through timely coordination of two policies.
    JEL: E30 E44 E50
    Date: 2022–10
  12. By: Ricardo Reis (London School of Economics (LSE); Centre for Macroeconomics (CFM))
    Abstract: With the profusion of measures of expected inflation (from market prices and from surveys of households, firms, and professionals) it is a mistake to focus on a single one while ignoring the others. This paper discusses four common arguments for a single focus, and finds each of them to be lacking. In the process, it isolates characteristics of different measures that models that combine them should take into account.
    Keywords: Phillips curve, anchoring, monetary policy, central banking
    JEL: E31 E52
    Date: 2023–01
  13. By: Benigno Pierpaolo; Canofari Paolo; Di Bartolomeo Giovanni; Messori Marcello
    Abstract: This paper uses an event-based analysis to describe how the European Central Bank’s (ECB’s) policy responses to the pandemic crisis have affected the European financial and economic system. The result of our exercise, which is based on the examination of the main measures taken by the ECB during 2020, is that these responses have positively affected the European economic system by improving banks’ lending activity and by indirectly creating room for expansionary fiscal policies in the euro area’s high-debt countries that do not have fiscal capacity.
    Date: 2022–10
  14. By: Francisco Gomes Pereira
    Abstract: Employing a Bayesian structural vector autoregressive (VAR) model, we estimate the impact of the European Central Bank’s (ECB) balance sheet expansionary policies (BSEP) on a range of economic and financial variables including real GDP, inflation, long-term sovereign bond yields, systemic stress, unemployment, bank loans, and equity markets in the period from 2009:Q1 to 2021:Q4. The main conclusion from this study is that more vulnerable euro area countries had larger magnitudes in desirable impulse responses to BSEPs shocks. To reach this conclusion, we estimated the same model for 16 euro area countries and used maximum, minimum, and cumulative impulse responses to assess the heterogenous responses to BSEPs across member states. We then attempt to find correlations of impulse responses with measures of financial and economic vulnerability such as debt-to-GDP ratios, unemployment, GDP per capita (PPP), and tier 1 bank capital ratios. Our results suggest that the magnitude of the responses are more pronounced in countries with higher levels of vulnerability. These findings are akin to theoretical assumptions that suggest that unconventional monetary policies are most effective in periods of severe systemic stress.
    Keywords: ECB; monetary policy; unconventional monetary policy; BVAR; euro area
    JEL: C11 E02 E52 E58 G02
    Date: 2023–01
  15. By: Antoine Camous
    Abstract: This paper studies how progressive fiscal policy influences the conduct of monetary policy in a tractable heterogeneous agent economies. A priori, progressive labor taxation is undesirable because it generates costly distortions. Nonetheless, it is an effective instrument to mitigate the inflation bias of monetary policy because it achieves a redistributive purpose. I analyze this commitment channel of progressive labor taxes through the lens of political conflicts. When agents vote on monetary and fiscal instruments, progressivity is decisive in curbing the inflation bias because it generates distributional conflicts, lower-productivity agents support higher labor taxes to preserve the consumption value of money holding and shift the burden of policy distortions to higher-productivity agents. Anticipating the reduction in inflation, agents unanimously desire to adopt a progressive fiscal system.
    Keywords: Monetary-Fiscal Policy, Progressive Labor Income Taxes, Inflation Bias, Time Consistency, Political Economy, Heterogeneous Agents
    JEL: E02 E42 E52 E61 E62
    Date: 2023–01
  16. By: Oleksiy Kryvtsov; James (Jim) C. MacGee; Luis Uzeda
    Abstract: The rise in inflation in 2021–22 sparked a growing literature and debate over the causes of the surge as well as the near- and medium-term path for inflation. This review offers three key messages. First, the exceptional nature of shocks resulting from the COVID-19 pandemic and geopolitical events drove the surge in inflation and the initial underestimation by many central banks of the extent of inflationary pressures. Second, the pandemic may have accelerated structural changes in goods and labour markets, which are likely to put pressure on goods prices and wages in the medium and long term. Third, the resulting shifts in relative prices for goods, services and labour are unlikely to be large enough to threaten a return of inflation to target but may require somewhat higher interest rates than those in the decade before the pandemic.
    Keywords: Inflation and prices; Inflation targets; Monetary policy
    JEL: E31 E52 E58
    Date: 2023–01
  17. By: Martien Lamers; Thomas Present; Nicolas Soenen; Rudi Vander Vennet (-)
    Abstract: We investigate the effectiveness of the Bank Recovery and Resolution Directive (BRRD) in mitigating the transmission of credit risk from banks to their sovereign, using CDS spreads to capture bank and sovereign credit risk for a sample of 43 banks in 8 Euro Area countries over the period 2009-2020. If the BRRD bail-in framework is credible, changes in bank default risk should not be transmitted to sovereign risk. In a novel approach we use banks’ earnings announcements to identify exogenous shocks to bank credit risk and investigate to what extent bank risk is transmitted to sovereign risk before and during the BRRD era. We find that bank-to-sovereign risk transmission has diminished after the introduction of the BRRD, suggesting that financial markets judge the BRRD framework as credible. The decline in bank-sovereign risk transmission is particularly significant in the periphery Euro Area countries, especially Italy and Spain, where the bank-sovereign nexus was most pronounced during the sovereign debt crisis. We report that the lower bank-to-sovereign credit risk transmission is associated with the parliamentary approval of the BRRD and not with the OMT program launched by the ECB to affect sovereign yield spreads, nor with specific bail-in or bailout cases which occurred during the BRRD era. Finally, we document that the reduction in risk transmission is most pronounced for banks classified as a Global Systemically Important Bank (G-SIB), stressing the importance of additional capital buffers imposed by Basel III.
    Keywords: BRRD, bank-sovereign nexus, bank-to-sovereign risk channel, bank earnings announcement, CDS spread
    JEL: C58 G28 G32
    Date: 2023–01
  18. By: Bernardino Adão; André Silva; João Gama
    Abstract: We show that the effectiveness of monetary policy changes with the labor income share. We do this in the context of a continuous time cash-in-advance model with heterogeneous agents and market segmentation. It turns out that the current price level depends on future interest rates through an integral equation. The solution of this integral equation reveals that, after an increase in interest rates, a larger income share implies larger reductions in money, prices and inflation. Monetary policy is more powerful in countries with a higher labor income share.
    JEL: C6 E3 E4 E5
    Date: 2022
  19. By: Mr. Yunhui Zhao; Francesco Beraldi
    Abstract: The COVID-19 pandemic further extended the multi-year housing boom in advanced economies and emerging markets alike against massive monetary easing during the pandemic. In this paper, we analyze the pricing-out phenomenon in the U.S. residential housing market due to higher house prices associated with monetary easing. We first set up a stylized general equilibrium model and show that although monetary easing decreases the mortgage payment burden, it would raise house prices, lower housing affordability for first-time homebuyers, and increase housing wealth inequality between first-time and repeat homebuyers. We then use the U.S. household-level data to quantify the effect of the house price change on housing affordability relative to that of the interest rate change. We find evidence of the pricing-out effect for all homebuyers; moreover, we find that the pricing-out effect is stronger for first-time homebuyers than for repeat homebuyers. The paper highlights the importance of accounting for general equilibrium effects and distributional implications of monetary policy while assessing housing affordability. It also calls for complementing monetary easing with well-targeted policy measures that can boost housing affordability, particularly for first-time and lower-income households. Such measures are also needed during aggressive monetary tightening, given that the fall in house prices may be insufficient or too slow to fully offset the immediate adverse impact of higher rates on housing affordability.
    Keywords: Pricing-Out, U.S. Housing Market, Housing Affordability, Distributional Effects, Monetary Policy
    Date: 2023–01–06
  20. By: Canofari Paolo; Di Bartolomeo Giovanni; Messori Marcello
    Abstract: This paper examines the impact of exogenous shocks on sovereign debts in an incomplete monetary union. We assume that financial stability is a public good that sovereign debt shocks can undermine in fragile (peripheral) members. Our model shows that, unlike the common misconception, active monetary policies do not induce the peripheral government to relax its fiscal constraints; on the contrary, these policies tend to incentivize fiscal discipline by reducing the cost of balance consolidation. Active monetary policies, in fact, partially reallocate the stabilization costs from the periphery to the core of the union, preserving the common good and facilitating fiscal discipline in the periphery.
    Date: 2022–10
  21. By: Sandra Gomes; Pascal Jacquinot; Matija Lozej
    Abstract: Differences in labour market institutions and regulations between countries of the monetary union can cause divergent responses even to a common shock. We augment a multi-country model of the euro area with search and matching framework that differs across Ricardian and hand-to-mouth households. In this setting, we investigate the implications of crosscountry heterogeneity in labour market institutions for the conduct of monetary policy in a monetary union. We compute responses to an expansionary demand shock and to an inflationary supply shock under the Taylor rule, asymmetric unemployment targeting, and average inflation targeting. For each rule we distinguish between cases with zero weight on the unemployment gap and a negative response to rising unemployment Across all rules, responding to unemployment leads to lower losses of employment and higher inflation. Responding to unemployment reduces cross-country differences within the monetary union and the differences in consumption levels of rich and poor households.
    JEL: E24 E32 E43 E52 F45
    Date: 2023
  22. By: Joshua Bosshardt; Ali Kakhbod; Farzad Saidi
    Abstract: We examine how banks’ liquidity requirements affect their incentives to take risk with their remaining illiquid assets. Our model predicts that banks with more stable liabilities are more likely to engage in risk taking in response to tighter liquidity requirements. This prediction is borne out in transaction-level data on corporate and mortgage loans for U.S. banks subject to the liquidity coverage ratio (LCR). For identification, we exploit variation in long-term bank bonds held by insurance companies that are not affected by the LCR. Our results point to a trade-off between bank risk taking and ensuring funding resilience over different horizons.
    Keywords: Liquidity Regulation, Bank Risk Taking, Insurance Sector, LCR, NSFR
    JEL: G20 G21 G22 G28
    Date: 2023–01
  23. By: Markus Leippold (University of Zurich; Swiss Finance Institute); Vincent Wolff (University of Zurich - Department of Banking and Finance)
    Abstract: Næs, Skjeltorp, and Ødegaard (2011) provide empirical evidence that stock market liquidity contains leading information about future economic activity. Their result suggests a rebalancing of small, increasingly illiquid to large stocks in recession times, an expression of “flight-to-quality”. We show that the relationship no longer holds due to the Fed’s accommodative monetary policy to buoy stock markets in crisis starting in the 1990s. Moreover, we document that liquidity dry-ups in small stocks no longer coincide with recessions. The Fed’s interventions mute the systematic link between monetary conditions and aggregate stock market liquidity’s well-established business cycle component.
    Keywords: Financial Markets and the Macroeconomy, Liquidity, Monetary Policy
    JEL: G10 E52
    Date: 2022–12
  24. By: Chan, Jenny; Diz, Sebastian; Kanngiesser, Derrick
    Abstract: How does household heterogeneity affect the transmission of an energy price shock? What are the implications for monetary policy? We develop a small, open-economy TANK model that features labor and an energy import good as complementary production inputs (Gas-TANK). Given such complementarities, higher energy prices reduce the labor share of total income. Due to borrowing constraints, this translates into a drop in aggregate demand. Higher price flexibility insures firm profits from adverse energy price shocks, further depressing labor income and demand. We illustrate how the transmission of shocks in a RANK versus a TANK depends on the degree of complementarity between energy and labor in production and the degree of price rigidities. Optimal monetary policy is less contractionary in a TANK and can even be expansionary when credit constraints are severe. Finally, the contractionary effect of an energy price shock on demand cannot be generalized to alternate supply shocks, as the specific nature of the supply shock affects how resources are redistributed in the economy.
    Keywords: Heterogenous agent models, business cycle fluctuations, energy, monetary policy
    JEL: E5
    Date: 2022–10
  25. By: Julien Reynaud; Juan-Pablo Erraez
    Abstract: A textbook argument in favor of adopting another country’s legal tender is that it imposes strong constraints on money creation and therefore fiscal dominance. In Ecuador, an officially dollarized economy since January 2000, a series of accounting practices and subsequent changes in legislations approved over the period 2009-2014 allowed an expansion of the Central Bank of Ecuador’s (CBE) balance sheet to finance the central government. At its peak, central bank financing of the government represented 10 percent of GDP. This resulted in large liabilities to the CBE that translated into low reserve coverage, putting the public and private financial systems and ultimately the dollarization regime at risk. In this paper, we first present the legal and accounting processes behind the expansion of the CBE's balance sheet and some stylized facts. In the second section, we establish a stress test-like methodology to show how the expansion of the CBE’s balance sheet induced strong pressures on CBE’s liquidity. Ultimately, such liquidity stress at the CBE translated into high cash inflows needs, i.e. external debt, for the central government.
    Keywords: Central bank; balance sheet expansion; fiscal dominance; central bank financing; financing of the government; accounting practice; liquidity ration; CBE balance sheet; CBE liability; International reserves; State-owned banks; Financial statements; Bank deposits; Public sector
    Date: 2022–12–02
  26. By: Kerem Tuzcuoglu
    Abstract: The Risk Amplification Macro Model (RAMM) is a new nonlinear two-country dynamic model that captures rare but severe adverse shocks. Tail risk arises from heightened financial stress abroad or in Canada that triggers a regime change with a negative feedback loop to the real economy. We rely on a combination of sign, zero and elasticity restrictions to identify structural shocks. The foreign block (global and US variables) impacts the domestic block (a large number of Canadian macrofinancial variables), but not vice-versa. Simulations suggest that tighter financial conditions in the United States can spill over to Canada, and a regime change in macrofinancial elasticities provides a good replication of economic downturns. The RAMM can be used to assess the financial stability implications of both domestic and foreign-originated risk scenarios.
    Keywords: Business fluctuations and cycles; Econometric and statistical methods; Financial stability; Monetary policy transmission
    JEL: C51 E37 E44 F44
    Date: 2023
  27. By: Benigno Pierpaolo; Canofari Paolo; Di Bartolomeo Giovanni; Messori Marcello
    Abstract: The euro area may be about to experience something new: fragmentations in its financial markets in a situation characterized by a high inflation rate. We argue that the euro area has only two options in such a scenario. First, countries facing tight financing conditions could apply for European aid procedures at the European Stability Mechanism to activate the Outright Monetary Transactions program. Second, these countries could find protection in strengthening a central fiscal capacity and in compliance with new country-specific central fiscal rules. Selecting one of these alternative options would lead to designing a very different architecture for the European Union.
    Date: 2022–12

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